PROJECTION ASSUMPTION GUIDELINES

PROJECTION ASSUMPTION GUIDELINES

Nathalie Bachand, A.S.A., F.Pl. Derek Dedman, CFP?, CFA

Martin Dupras, A.S.A., F.Pl., M.Fisc., ASC Daniel Laverdi?re, A.S.A., F.Pl. A. Kim Young, CFP?, FCIA

Effective Date: April 30, 2019

TABLE OF CONTENTS

1. BACKGROUND ..........................................................................................................................2 2. CONSIDERATIONS FOR ESTABLISHING THE GUIDELINES...............................................4 3. ASSUMPTIONS SUBJECT TO THE GUIDELINES...................................................................6 4. GUIDELINES FOR 2019 .......................................................................................................... 13 5. SAMPLE APPLICATION .......................................................................................................... 14 6. FINANCIAL GUIDELINES FOR PREVIOUS YEARS .............................................................. 15

Assumptions

1. BACKGROUND

An important facet of the financial planner's work is to make a variety of projections (retirement needs and retirement income, insurance needs, children's education funding needs, etc.). In making projections, financial planners are bound by method, rather than results. The purpose of this document is to map out the assumptions to use in the preparation of these projections.

The Guidelines are intended as a guide and are appropriate for making long-term (10+ years) financial projections that are free from the potential biases of financial planners. Predicting the direction the economy will take and how financial markets will evolve is a difficult exercise requiring the integration of a large number of variables and highly sophisticated valuation models. To protect themselves and their clients, financial planners are encouraged to rely on these Guidelines.

Financial planners should develop sensitivity analyses to illustrate and assess the impact of changes in assumptions on clients' financial positions. This is particularly important when client goals may be at risk.

a) Updating and useful life of the Guidelines The Guidelines are updated annually. Although some of the assumptions set out in these Guidelines may change from time to time, this does not mean that projections based on previously published assumptions are no longer valid. In fact, projections are considered valid at the time of preparation.

b) Use of the Guidelines The use of the Guidelines is strongly encouraged to promote trust and confidence in the financial planner's projections, given their objectivity and basis in reliable sources.

That said, a financial planner is in the best position to understand their clients' unique circumstances. Because every client situation is different, assumptions that vary from the Guidelines may be used.

Assumptions may also differ from the Guidelines based on local market peculiarities. As an example, projections of education costs, which tend to be impacted by local market differences, may justify using an inflation rate that differs from the Guidelines. Projections of salary increases may justify an inflation rate that differs from the Guidelines, where clients give good reason for the change.

Page | 2

Assumptions

c) Compliance with the Guidelines In all cases, assumptions used should be documented, with sound rationale, and clearly communicated to clients. The use of the Guidelines can be disclosed using a statement such as the following:

? Projection prepared using the IQPF and FP Canada Standards Council Projection Assumption Guidelines.

? Analysis prepared using the IQPF and FP Canada Standards Council Projection Assumption Guidelines.

? Study prepared using the IQPF and FP Canada Standards Council Projection Assumption Guidelines.

? Calculation made using the IQPF and FP Canada Standards Council Projection Assumption Guidelines.

d) Deviation margins Where appropriate, financial planners may deviate within plus or minus 0.5% from the rate of return assumptions and continue to be in compliance with the Guidelines.

In making a judgement call around whether to deviate 0.5% up or down, financial planners may consider the following factors:

? The impact of a variation in return on the expected lifestyle of clients. As an example, it would not be prudent to increase return assumptions to "force" a projection that secures a client's goal.

? The propensity of clients to buy high and sell low, thereby reducing their longterm rates of return. Where the propensity is high, one may consider reducing the expected rate of return on their portfolio.1

? The degree to which clients rely on professional financial advice in managing their investment portfolio, including regular rebalancing of their portfolio, which may increase their long-term rates of return.2

Please note that the deviation margins relate to the rate of return guidelines only, not to the inflation rate guidelines. Any deviation in excess of 0.5% in either direction of the guidelines should be reasonable and supportable.

e) Effective date of the Guidelines The Guidelines for 2019 are effective as at April 30, 2019.

1 Dalbar. (2014). 2014 DALBAR QAIB Highlights Futility of Investor Education [Press release]. Retrieved from release/2014/04/09/625908/10076149/en/2014-DALBAR-QAIB-Highlights-Futility-ofInvestor-Education.html. 2 Masters, S. J. (2003). Rebalancing. The Journal of Portfolio Management,29(3), 52-57.

Page | 3

Assumptions

2. CONSIDERATIONS FOR ESTABLISHING THE GUIDELINES

a) Use of external sources The Guidelines were established using a variety of reliable and publicly available data sources. They do not represent the individual opinions of the members of the Projection Assumption Guideline Committee, IQPF or FP Canada Standards Council.

Using numerous sources of data also eliminates the potential bias that may be created by relying on any single source.

The Addendum to the 2019 Projection Assumption Guidelines provides links to sources, data and calculations used in the development of the Guidelines. The Addendum is provided for transparency and replicability of the Guidelines by financial planners and firms.

Note that FP Canada Standards Council and IQPF distributed a long-term expectations survey to source data previously obtained through the Willis Towers Watson Annual Canadian Investment Perspectives Survey, which was last completed in 2016. FP Canada and IQPF thank all participants, including AON, Hexavest, IG Wealth Management, Desjardins, Normandin Beaudry, Optimum, PWL Capital Inc., WDS Investment Management, WisdomTree Asset Management, and all other contributors.

b) Aim of stability The fact that the Quebec Pension Plan and Canada Pension Plan actuarial reports are updated every three years ensures the Guidelines will remain stable.

As well, to ensure stability from year to year and more closely reflect the underlying data, the Guidelines will continue to be rounded to the nearest 0.1%,3 as has been done since 2015 when it was changed from rounding to the nearest 0.25%.

c) Limitations The Guidelines cover the main asset classesshort-term assets, Canadian fixed income, Canadian equities, foreign developed market equities (including U.S. equities and Europe, Australia and Far East equities) and emerging market equities.

3 By rounding to the nearest .25%, a 3.10% result would generate a guideline of 3.00%, while a result of 3.15% would generate a result of 3.25%. By rounding to the nearest .1%, a 3.10% result would maintain the guideline of 3.10%, while a result of 3.15% would generate a guideline of 3.20%.

Page | 4

Assumptions

Guidelines are not provided for other asset classes, including global bonds, U.S. equities, small-capitalization equities, value and growth equities, because they are not addressed in the CPP and QPP actuarial valuation reports. The guideline for foreign developed equities may be used as a proxy for U.S. equities. Similarly, guidelines are not provided for changes in the real estate market for the following reasons:

? Separate guidelines would have been required for residential, commercial and industrial buildings.

? A regional index would also have been necessary (the real estate market behaves differently in Montr?al, Qu?bec City, Toronto and Vancouver).

When making assumptions around real estate growth, it is important to consider an appropriate starting valuation for the property and use an inflation-based assumption that is suitable based on the local market context. Guidelines are not provided for exchange rates since the net long-term effect of changes in exchange rates is generally nil. Financial planners should develop sensitivity analysis to illustrate and assess the potential ramifications of changes in exchange rates. Clients who may require income in a foreign currency may wish to maintain assets in that foreign currency to avoid foreign exchange rate risk. It is also important to note that the Guidelines do not contemplate personal risk profiles. Since an individual's risk profile or change in risk profile may have consequences at least as significant as or more significant than the rate of return guidelines used in developing financial projections, sound risk assessments are critical.

Page | 5

Assumptions

3. ASSUMPTIONS SUBJECT TO THE GUIDELINES

Two types of assumptions are subject to guidelines: financial assumptions (inflation, changes in the year's maximum pensionable earnings [YMPE or MPE], long-term returns on shortterm investments, fixed-income securities, Canadian equities, foreign developed-market equities and emerging-market equities, and borrowing rates) and demographic assumptions (life expectancy).

a) Inflation The inflation assumption is central to the preparation of medium- and long-term projections. The inflation assumption is made by combining the inflation assumptions from the following sources (each weighted at 25%):

? the average of the inflation assumptions for 30 years (2017 to 2046) used in the most recent Quebec Pension Plan (QPP) actuarial report4

? the average of the inflation assumptions for 30 years (2017 to 2046) used in the most recent Canada Pension Plan (CPP) actuarial report5

? Result of the 2019 FP Canada/IQPF survey of investment professionals. The reduced average was used where the highest and lowest value were removed.

? current Bank of Canada target inflation rate

The result of this calculation is rounded to the nearest 0.10%.

A discussion was held about the use of separate inflation rates for older individuals or high earners. Two studies by Radu Chiru of Statistics Canada6 demonstrate that there are small differences in inflation for these two groups of Canadians as compared to others, but these differences are not deemed to be material.

i. Wage increases The inflation assumption can be used to project wage increases by adding 1.00% to reflect productivity gains, merit and advancement.7

It may be appropriate to deviate from the guidelines where a client reasonably expects higher or lower wage increases for the foreseeable future. As an example, where a client is reaching the end of his or her career or is in a position with no real chance of advancement, the financial planner may consider a wage increase equal to or less than inflation.

4 December 31, 2015 QPP actuarial report, published fall 2016. 5 December 31, 2015 CPP actuarial report, published September 2016. 6 Is Inflation Higher for Seniors? (2005) Catalogue no. 11-621-MWE2005027 and Does Inflation Vary with Income? (2005) Catalogue no. 11-621- MWE2005030. 7 In the most recent QPP and CPP actuarial reports, a final margin of 1.10% between wage increases and inflation was applied

Page | 6

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download